Option Investor

Daily Newsletter, Wednesday, 06/14/2006

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Table of Contents

  1. Market Wrap
  2. New Option Plays
  3. Trader's Corner

Market Wrap

Beige Boo

When roughing out this article, "Beige Book" was misspelled "Beige Boo." The spelling proved appropriate, however. The release of the Beige Book was the second important release of the day, with the CPI being the first. Only after market participants had assured themselves that nothing startling was in those reports were markets free to relieve oversold pressure. They did that in the most volatile manner possible, first trapping many a bear entering on the breakdown below the previous low-of-the day. Chart characteristics prove that the most important indices to watch today might have been the BIX and BKX.

Three different articles this week expressed varying viewpoints as to how important the CPI figure would be to the Fed. CPI was variously termed the only data on consumer inflation that the FOMC would receive ahead of the June 29 meeting, not as important as the PCE, and dangerous to "pooh-pooh" as an indicator of what the Fed might do. In last night's Wrap, Jim Brown set forth the other global forces that were likely impacting our markets as well as other bourses across the globe. Other commentators had ignored the impact of those forces, focusing solely on the impending CPI release.

Overnight, futures traders were betting, however, that CPI figures were baked into the markets already, and the bulls among them took an immediate but temporary blow when the core number was hotter than expected. One source pegged expectations for May's consumer price index at a 0.4 percent rise, down from the previous 0.6 percent, with core CPI predictions ranging from an increase of 0.2-0.3 percent, flat or slightly lower when compared to the previous 0.3 percent increase.


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Most sources appeared to favor the 0.2 percent increase, but the 0.3 percent rate was the one delivered. Jim had also mentioned last night how rent costs might impact the number, and, indeed, owners' equivalent rent, one-fourth of the CPI, rose 0.6 percent, its largest gain in 16 years. Excluding shelter, the core CPI rose only 0.2 percent. The headline CPI number was, of course, driven higher by energy costs, rising 4.9 percent and at an annual rate of 69.4 percent.

Over the last year, CPI rose 4.2 percent, and 5.2 percent at an annualized rate. Core CPI rose 2.4 percent year over year and at an annualized pace of 3.1 percent so far this year, both numbers well above that comfort zone the FOMC members have mentioned so often the last week.

Immediately after the release, Fed funds were predicting were predicting a higher than quarter-point interest rate hike, increasing the chances that the Fed would raise rates at the next two meetings. (For those of who would like to see how these probabilities are calculated, see this weekend's Trader's Corner article.)

Indices bounced after the data had been digested. Light volume, climbing bond yields and weak financials early in the session did not provide the needed trust upon which to build on the post-CPI climb, however. The SOX led the way higher, but the SPX spent the entire morning coiling in a triangle above yesterday's low. The SPX's coil and that on many indices reflected the skittishness of market participants, especially with the afternoon's release of the Beige Book still to come and with Fed Governors Bies and Fisher scheduled to speak. Even the market-leading SOX began coiling after reaching its early-morning high.

The deeper inversion of the two-year note when compared to the 10-year tamped down early bullishness, too. Bulls weren't cheered by the prospect of slowing growth and higher interest rates, although the prospect isn't a new one. Breadth indicators changed sides several times, sometimes favoring bulls and sometimes bears.

When the break out of those coils occurred, it occurred to the downside just prior to the release of the Beige Book. The move could have been due to comments made by Dallas Fed Chief Fisher but also occurred during a typical stop-running time of day. The SPX plunged to a heart-stopping 1219.70 low at about 1:40, and then began climbing, increasing the force of its climb after the Beige Book was released.

With Fisher still on the wires, the volatility wasn't finished, however, and the SPX, along with several other indices, was to drop to a new low of the day after that initial post-Beige-Book zoom. Whether the markets had reacted to continuing statements by Dallas Fed Chief Fisher, as some surmised, or whether market makers wanted to make sure that they were the only ones invited to the rally party and deliberately trapped bears, that new low was to produce a strong recovery into the end of the day.

Another event was quietly occurring, however. While indices were hitting that new low of the day, the BIX, the S&P Banks Index, was dropping within 50 cents of its 200-sma, and the BKX, the KBW Bank Index, was dropping with 20 cents of its 200-sma. It may have been recovery in the BIX and BKX which finally allowed indices to bounce and hold their gains.

Was this just short-covering or something more? The SPX weekly chart offers some levels to watch.

Annotated Weekly Chart of the SPX:

This weekly chart shows that after violating this support on a daily basis, the SPX has just bounced up to retest the broken support. The SPX needs to hold at this level or above on a weekly closing basis.

A weekly close is still a long way away, particularly on an option expiration week that has proven particularly volatile. Walk away from the screen for a drink of water, and you may find the outlook completely changed by the time you return. Some charting services, on unnamed one in particular, has been running slow, so market participants can't even count on alerts sounding to warn them of sudden drops or climbs. However, there is an intraday chart that might prove helpful. Since Monday morning, each bounce of the SPX has been stopped with uncanny accuracy on the three-minute 100/130-ema's. That is, until this afternoon's end-of day run, when the SPX finally broke through. Those averages can perhaps be used as bullish/bearish barometers for those who brave souls who want to trade in this environment. I would suggest that we should see a pullback to retest those averages, but if a true short-term rally has begun, fueled as it might be by short-covering ahead of option expiration.

Annotated Three-Minute Chart of the SPX:

Watch for a potential H&S to form with a neckline along these averages.

While the OEX also spent the week--until this afternoon--getting knocked down each time it tested its three-minute 100/130-ema's, resistance on other indices wasn't so closely attuned to these averages on this time interval. Until this afternoon, the Dow, however, did appear to be bounced back from tests of the five-minute versions of these averages, so they might be used to measure the Dow's short-term bullishness or bearishness. Those averages for the Dow are currently at 10700.24 and 10776.23, respectively, but check your charting services for current values for the Dow's five-minute 100/130-ema's as the day proceeds tomorrow.

Annotated Daily Chart of the Dow:

The Dow still has a little room to run before hitting that next resistance level, but only a little, and that statement characterizes the Nasdaq, too.

Annotated Daily Weekly of the Nasdaq:

Today, Goldman Sachs upgraded several companies in the semiconductor equipment sector and several chip companies, many of those also in the SOX. INTC was upgraded to an outperform rating, with the firm expressing its belief that the company's margins had probably bottomed. INTC closed higher by 3.56 percent. Competitor AMAT was upgraded to an in-line rating, with an analyst with GS saying that earnings should grow, but through expense controls and lower share counts, perhaps not exactly exciting news for investors. AMAT closed higher by 1.85 percent. SanDisk Corp. was upgraded to an in-line rating, too.

The upgrade of the semiconductor equipment sector was perhaps a backhanded compliment because the firm's analyst believes the stocks in that sector could still decline and offers the suggestion that, while shorts might be covered, it was not yet time to buy those stocks until there had been capitulation in the sector, since prices could still decline further.

The SOX gained 1.37 percent today.

Annotated Daily of the SOX:

The SOX did bounce, but its bounce is not yet convincing. Until the week closes, we won't know whether it or many other indices broke through their long-term support levels or merely tested them on an intra-week basis.

The DJUSHB, the Dow Jones U.S. Home Construction Index, also bounced, but unconvincingly. Some good news came from the Mortgage Bankers Association's weekly report, although that good news may be just an upward blip after a series of declines. At 7:00, the Mortgage Bankers Association released its weekly mortgage application volume survey for the week that ended June 9. After many weeks of decreasing application numbers, the measure for total applications rose 7 percent. Seasonally adjusted volume for home purchase applications rose 4.8 percent, and for refinancing applications, 10.6 percent. The percentage of applications that were intended for refinancing rose to 35.7 percent, up from the previous week's 34.2 percent. Average contract interest rates for 30-year fixed-rate mortgages inched up to 6.61 percent from the previous 6.60 percent. Influenced by several weeks of down-turning numbers, the four-week moving average of total applications was lower by 0.7 percent, however.

Crude prices spent another day clinging to the daily 100-sma, not yet dropping to test a long-term ascending trendline now at about 67.33. Expectations for crude inventories were for a decline of 1 million barrels in crude and a gain of 2 million barrels in gasoline inventories. The American Petroleum Institute (API) reported that crude inventories climbed 3.3 million barrels, contradicting the Department of Energy's report of a decline of 900,000 barrels. The API reported that motor gasoline inventories rose 2.9 million barrels, in line with the Department of Energy's report of a rise of 2.9 million barrels, both above the forecast. The API and the government differed on distillate inventories, too, with the API saying they fell 181,000 barrels while the government said they rose 2.1 million barrels.

If the crude inventories impacted markets, it was difficult to tell. The SPX had been in the middle of a decline through the morning's triangle at the time those inventory numbers were released, and it merely continued through to the bottom support and bounced from that, still coiling before the breakdown that was to occur later.

Although talks concerning Iran's nuclear policies had deteriorated, today a Spanish official noted that Iran's foreign minister called the West's offered incentives a "step forward." China weighed in, too, with a Chinese foreign ministry official encouraging Iran to adopt an attitude toward the discussion that would be pragmatic, flexible and positive. One forex news source speculates that the European Union's drafted statement to be presented at the IAEA meeting could be termed "conciliatory" toward Iran.

Some wish all the FOMC members would take a nice relaxing vacation and stop hammering markets, but markets heard from two today. Governor Bies' prepared address to mortgage bankers today reiterated the view that while the housing sector was expected to decline, she did not anticipate a crash in that sector. Declines in housing prices might dampen consumer demand, but the Fed had accounted for such action in the outlook. She cautioned that some bank losses might result from a concentration of commercial real estate loans among small banks and risky loans among all banks.

Additionally, she addressed resource use, noting that while some skilled workers are in short supply, the U.S. doesn't need to increase its job growth as much as previously. She expects labor growth to slow to a more sustainable rate of about 3.5 percent or less. The Fed wants to see a slowing of growth without a hard landing. The GDP could be slowed by as much as 0.5 percent if household wealth does not increase.

Dallas Fed Governor Fisher also spoke, reiterating that he is serious about fighting inflation. His statement that it was better to err on the side of caution regarding inflation may also have contributed to that pre-Beige-Book drop, as the time stamp appeared about right, and later, after this paragraph had been written, I heard that CNBC was also saying that Fisher's statements had caused the drop. While Fisher had encouraging things to say about business investment being capable of balancing a weaker housing sector and the economy's strength, he warned that inflation expectations pose the biggest risk to the economy. He did acknowledge that the impact of the previous rate hikes on inflation was a lagging one.

Whether it was Fisher's statement or the imminent release of the Fed's Beige Book or a stop-running move that sent indices into the first plunge of the day, the Beige Book release still drew much attention, with this release being one of the two arguably most important releases of the day and the week.

At 2:00, the Fed's Beige Book was released. The Beige Book's full title is "Summary of Commentary on Current Economic Conditions by Federal Reserve District." It appears eight times each year, about two weeks before each FOMC meeting, and includes reports and interviews from and with economists, bank officials and other experts, all organized by district. FOMC members study the anecdotal information in this publication, looking for shifts in the economy since the previous meeting.

For all the volatility attending the Beige Book's release, this report is written about a week before its release, and various Fed governors have been speaking over the last couple of weeks, telegraphing their impressions. This reporter's impression going into the Beige Book was that, if it didn't say anything too out of line with what's already known, some of the selling pressure might let up. Fisher's comments kept knocking the knees out from under jittery bulls or else market makers were intent on one more move to trap bears and stop out the bulls, but after that last post-Beige-Book plunge to a new low of the day, the relief bounce did finally occur.

One salient point from this anecdotal compendium is that the economic activity has continued to expand across all 12 Fed districts, but the economy shows some signs of slowing. Consumer spending continues to increase. Wage pressures appear to be impacting only a few districts, but the Beige Book repeated Bies' comment that employers are having difficulty finding certain skilled workers. Energy costs are being passed on to a greater degree than previously, inflation pressures are firmer than they had been previously and growth appears to be cooling. Although not particularly cheerful news, these salient points do not appear to differ greatly from the message that numerous FOMC members have been expounding for several weeks. What may be new is the degree to which energy costs are being passed through.

After the release of the Beige Book, if the time stamp is correct, Dallas Fed chief Fisher spoke again, and again addressed the issue of whether the FOMC might go too far in raising rates. He assured listeners that, while it's a judgment call, FOMC members are trying to ensure that they do not go too far. Some interpreted these comments and others to mean that he thinks that the next tightening might produce a needed tempering of inflation pressures. Other experts still worry, given the well-known tendency of inflation to keep rising after the last tightening and the current FOMC members' intention to keep tightening until inflation is under control. They may not allow that typical continued but temporary increase in inflation, but insist on stamping it out before they let up, stamping out the economy along with inflation.

Some individual companies contributed to the outlook and the afternoon bounce. In addition to the upgrades received by some chip-related companies, BA received a Goldman Sach's upgrade after receiving another huge order. This one amounts to $4.5 billion. BA helped lead the blue chips stocks higher, gaining 6.53 percent by the close. Yesterday's story stock, QCOM, gained 3.36 percent, but as I page through random lists of stocks, I notice HDI up 4.39 percent, LLY up 3.02 percent, and one of tomorrow's reporting companies, KBH, up 2.20 percent.

The list of reporting companies for tomorrow is small. Continuing the parade of financials reporting this week, Bear Stearns (BSC) reports tomorrow before the open. Other reporting companies include ADBE, the already-mentioned KBH, PIR and PGR.

Tomorrow will be a day full of economic releases, however, beginning with initial jobless claims, continuing claims and the empire manufacturing (13.5 forecast, up from previous 12.5), all at 8:30. Next come net foreign security purchases at 9:00, followed by industrial production (0.2 percent forecast, down from previous 0.8 percent) and capacity utilization (82.0 percent forecast, inching up from 81.9 percent) at 9:15. At noon, the Philly fed releases its number (11.0 forecast, down from previous 14.4). I would normally say that these numbers should not be as important as today's, but in this market climate and on the last trading day of many options and futures before Friday morning settlement, anything is important. New OEX traders should note that the June OEX options trade through Friday and settlement is determined by the closing values of the component stocks.

So was today's end-of-day action a short-covering bounce? Certainly. Will it continue? Breadth indicators were mixed, with volume strong, advancers barely beating decliners, new lows trumping new highs, but with up volume about double down volume.

The daily action proves difficult to interpret, except that dim memory, back when markets used to have normal volatility, is that this kind of action used to attend the bottoming or topping-out process. It's possible that markets are attempting a bottoming process, employing a jack-hammer-like action to pound down to bedrock, to a level that will prove strong enough to build upon. My outlook is a weekly one, so all I can determine at this point is what I've shown on the charts above, that long-term weekly support levels are being tested, and that we won't know the outcome until Friday's close.

Bears and bulls alike were stopped today, likely multiple times. Markets collapsed without warning, on an errant word or two from Fed governors and the rallies, brief as some were, were just as sudden. In that kind of climate, it's nearly impossible to day trade, and even experienced traders were left groaning today. Even if they were right about direction, they often were stopped just before the market moved that direction.

If you're determined to trade intraday or if you're already in trades that were established a while ago and want to know what to expect for opex, the best I can do is point you again to that SPX chart of the three-minute 100/130-ema's and tell you to watch how the SPX performs with relationship to those averages. Use the five-minute version for the Dow and the 3-minute version for the SOX and Nasdaq, realizing that the SOX and Nasdaq are both going to overrun these averages from time to time, with the breakout below or above occasionally being fake-out moves. They're just not as reliably attuned to those averages as were the SPX and OEX. The 15-minute versions are better for the SOX and Nasdaq, but neither are above those versions yet. Watch for those 15-minute averages as possible resistance, if hit.

On any and all of those indices, test various times frames, because if markets slow down or move faster (almost impossible to move faster, it seems), then you may find that either a 7- or 1-minute chart proves more helpful. Most importantly, if in bullish plays, you want the financials to lend their strength. Watch the financials.

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Play Editor's note: Unfortunately, technical difficulties prevent us from bringing you any play updates today.


Trader's Corner


You hear trader and analyst types talk about 'capitulation', referring to the final stage of these relentless type free fall declines such as may have wrapped up today. Capitulation means to throw in the towel. It's where you see or feel yourself the attitude expressed by 'get me OUT of this market, I can't stand it; this thing is never going to STOP going down. Since the market is so driven ultimately by investor psychology and expectations, capitulation is a powerful and cathartic event that often is associated with market bottoms and stabilizing prices.

Charles Dow didn't use the term capitulation that I recall reading about him, but did talk about the same emotional state of mind. The final sort of panic selling, where people feel that if they don't exit they are going to lose their shirt; and the vacation house and the second car, etc! Or, in this day and age, the panic may be to retirement money socked into stock mutual funds in their 401k plans.

Someone I listed to last night on one of the market wrap shows talked about bottoms coming in a final 'accidental event'; by that, meaning some final bit of bad news that causes the last bit of selling for awhile anyway; and, after this news comes out, market participants figure, 'well, the worst is over'.

I look at capitulation somewhere differently and use and tend to rely on my equities call to put daily volume indicator for the CBOE. I look for a simple ONE-DAY reading that suggests put volumes are close to equaling call volume. This event tends to reflect that same type emotional trigger as what the other gentlemen I mentioned was talking about. There has not been such a 'capitulation' type day in my call to put volume ratio yet in the past week and half's relentless further decline.

Trading volumes that are far above the average daily volume is another type of event that can reflect capitulation. You can track total exchange volumes to get an idea of when this happens or use a proxy, like the daily volume numbers for the Nasdaq 100 tracking stocks, symbol QQQQ.

I thought that the Thursday, 6/8 QQQQ volume spike might be a capitulation type 'volume climax' as day saw a big spike in trading volume. Actually the Q's haven't fallen all that much further since then and volume, as they say, often PRECEDES price (turnarounds).

Market sentiment is a major way to measure capitulation by traders and investors. Sometimes the market will reach a bottom, rebound a bit or even substantially, then drop back to the area of the prior lows, maybe even dip under the prior intraday low. This type action is sometimes when I will see at least a 1-day jump in put volume, relative to call activity, where put volume gets close to equaling call volume.

A retreat to a prior low is another way to gauge a milder form of 'capitulation'. Investors decide that they just aren't going to buy unless one key major index or the indexes in general get back to some important prior low. The Nasdaq 100 (NDX) has now retraced all of its gains made since its October bottom.

And, I've noticed over the last 2-3 days some of the key Nasdaq biggies (big cap stocks) are starting to find some supporting buying interest.

There are other instances where there is no particular single capitulation event or news, nor a major spike in volume associated with emotional type single selling climaxes, but the market starts to show greater relative strength, with selling slowing down or drying up. NYSE and Nasdaq UP volume, especially on a 10-day moving average basis, contracts to a low level, hitting a reoccurring 'baseline' amount; this is close to happening in the Nasdaq, for the second time since the 4th week in May. That first instance, obviously NOT being associated with a bottom.

There are some charts that will illustrate some bottoming type indications, but do NOT YET illustrate the capitulation type selling trigger or jump in put volumes. Prices may lift some and these events come later, without prices necessarily sinking further or much further than they already have. Prices may of course just KEEP falling. I like to be ready and I can be early, once or twice on covering puts and doing some index call buying.

This is why I use close by stop or exit points in such circumstances. It's my particular style to try and ANTICIPATE significant tradable lows. I sometimes think it's my laziness in not wanting to 'stay glued to the tube' and be watching the market every minute for the definite signs of a reversal; that quick price rise and volume surge off a bottom. Besides I have other projects and business activities besides trading and watching the markets. I like to think it's the greatest challenge and ultimate satisfaction in figuring out the market's next move before it's upon us.


The S&P 500 (SPX) has retraced now 2/3rds or 66% of its last big run up. In an uptrend, once a retracement of a prior move gets to be more than 2/3rds, there is the strong possibility that the price will fall back to the area of the previous low.

Where SPX got to today is the area where it should stage a rally to start to at least inch above today's low, IF the Index is going to retrace part, not ALL, of its prior move. Stay tuned on that! A close under 1221, not reversed back to the upside the next day, starts to make the bullish prospects look dimmer.

The S&P 100 (OEX) daily chart below illustrates a couple of technical aspects not related just to retracements. But before leaving that subject, OEX has obeyed my two-day rule so to speak. The index closed under what is its 66% retracement yesterday but rallied the next day (today) back above this level.

This technical action may suggest that this group of stocks is digging into an area where there is buying interest (support). OEX and Dow 'bellwether' GE is holding up much better than the overall index, which should be encouraging to the bulls.

OEX is also oversold, but the retreat in the RSI seen above is not down as far as the price level seen when the RSI hit its low to date. This action is suggestive of a possible bullish price/RSI divergence. Stay tuned on that!

We still haven't seen the 'capitulation' event that would be suggested by my call to put volume ratio (lowermost section of the chart above) dipping into the 'oversold/extreme bearishness level'; but it has gotten closer. A rally followed by another slam might get that indicator line down again in that area. Or, just more of the same: relentless decline.

The Dow 30 (INDU) as shown in my next chart seems to have found some price stability and buying interest in the area between the 62 and 66% retracement. It's not unusual to see prices stabilize in this zone or after having this much of a decline. This event coupled with the oversold extreme suggested by the 21-day stochastic oversold reading, may suggest some follow through buying.

This is not to say leap into Dow Index (DJX) calls on this prospect. Even if today is a low for this move, there is usually another low made at or a bit above the first, before the Index is worth buying. It can take awhile for a bottom to form and call premiums erode way before a next rebound, which is often when there's a more sustained and faster upswing.

Reminds me of the Rock & Roll song, about you 'can go your own way', as the Nasdaq goes its own way. The Nasdaq Composite, as seen in this next chart, has exceeded a 2/3rds retracement of the last big advance and is getting close to a round trip 100% retracement of it. A retreat to the 2025 area, but not lower or much lower, sets up the possibility of a double bottom. But the Nasdaq 100 (NDX), which is the next chart after COMP is already there, having retraced ALL of its prior move.

The RSI is not 'confirming' this latest price low by its own move to a new low, which sets up a possible advance reading of a trend turnaround or rebound. Stay tuned on this prospect!

The Nas 100 (NDX) chart, big cap tech, is showing now a possible, emphasis on 'possible' double bottom low. Did I tell you that I LOVE to buy double bottoms, and short double tops. Good reliable chart patterns a lot of the time. And, you know where to put your stop out point; i.e., just under 1515 in the case of NDX.

There is a more pronounced bullish price/RSI divergence apparent in the NDX chart above than was seen in COMP. I did say 'possible' right? Stay very tuned in on this over subsequent days!

The NDX chart weekly chart next and last, is interesting in terms of the possible double bottom low idea I've spoken about above.
The noteworthy pattern in the NDX long-term chart below is that the Index has to date held above the low end of its uptrend channel, which intersects in the low-1500 area.

If NDX holds above the 1500 level, especially on a weekly close basis, then starts to work higher over time, then it's most likely a heck of buying opportunity ahead.

Please send any technical and Index-related questions for answer in Trader's Corner articles to support@optioninvestor.com with 'Leigh Stevens' in the Subject line.

** Good Trading Success! **


Today's Newsletter Notes: Market Wrap by Linda Piazza, Trader's Corner by Leigh Stevens, and all other plays and content by the Option Investor staff.


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